In The Midst of Subprime Litigation – News From the Trenches

This is the tenth in a series of brief articles that Moye White is sending to its clients and friends to provide practical advice about the opportunities and challenges presented by today's economy.

There is a building wave of litigation arising out of the subprime meltdown and resulting credit crisis. Businesses which have thus far weathered the storm are increasingly finding themselves as targets of lawsuits by consumers, other businesses and former partners or investors. Common claims in today’s market are discussed below.

Consumer vs. Business – Numerous state and federal statutes encourage consumer claims against commercial entities by providing for enhanced, in some cases treble, damage awards and or attorneys fees to prevailing plaintiffs. One of the most commonly abused statutes in this regard is the Uniform Consumer Protection Act (“UCPA”), which Colorado has adopted. The UCPA was intended to punish businesses for engaging in unfair and deceptive trade practices, such as “bait and switch” schemes, by providing for treble damages and attorneys fees. However, the language of the UCPA is so broad that many common consumer claims are being recast as deceptive trade practices under the Act. Additionally, the UCPA entitles plaintiffs to discover whether other customers have had a similar experience with the business, thereby greatly expanding the scope of the lawsuit and increasing the costs of defending the plaintiff’s claim. Other statutes, such as the Home Ownership and Equity Protection Act, the Fair Debt Collection Practices Act and the Fair Credit Reporting Act, provide economic incentives for consumers to vigorously pursue any claims, even those arising from good faith mistakes or with low actual damages, at great expense to a business.

Business vs. Business - When business is booming, profits can ease the pain arising out of a business transaction where one party was allegedly less than candid. In bad times, however, the same set of facts may result in litigation. This is particularly true among the complex web of businesses involved in the origination of subprime mortgages, such as mortgage brokers, appraisers and loan originators. These businesses are increasingly named as defendants in lawsuits alleging that their zeal to close another loan – and hence earn another commission – caused them to misstate the truth, thereby fraudulently inducing the ultimate purchaser (or holder of the note) to buy a pool of mortgages. In particular, mortgage brokers, appraisers and loan originators are vulnerable to lawsuits alleging that they turned a blind eye toward occupancy misrepresentations, suspicious credit bureau items, inflated incomes and incorrectly calculated debt-income ratios. Loan originators commonly sold pools of loans to investors pursuant to loan purchase agreements which were replete with representations and warranties by the originator concerning the nature and quality of loans being purchased. Holders of defaulted loans are now closely examining these agreements and are often invoking the “buy-back” provisions contained therein or claiming fraud. What is more, these loan purchase agreements often contained personal guarantees by the loan originators’ principals.

Investors vs. Business - Investment advisors, registered funds and affiliated broker dealers were among the first companies targeted by disgruntled investors following the credit collapse. As the value of investments dropped precipitously and large Wall Street firms started to collapse, investors – frequently in class actions – claimed that management and performance fees charged by advisers and funds were excessive and were based on inaccurate or artificially inflated valuations. Similarly, investors frequently claimed that marketing materials and disclosures failed to accurately disclose a company’s risk or strategy, leading to claims of “suitability” and breach of fiduciary duty. Broker dealers and clearing firms have also been targeted for allegedly failing to have adequate policies and procedures in place to accurately value investments or supervise retail broker dealers.

Nearly every business in the financial services industry has become a potential target in litigation arising from the subprime meltdown. These businesses should assess their risk and seek legal advice to formulate a strategy before they are named as parties in litigation. Doing so will minimize their potential exposure and maximize their chances to prevail in a lawsuit.

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Moye White LLP has prepared this bulletin to provide general information, however this bulletin does not provide legal advice and does not create an attorney-client relationship between the reader and Moye White. No legal or business decision should be based solely on the content of this bulletin.